Silence gives consent: the speeches given by J. Yellen and M. Draghi at the annual central bankers conference in Jackson Hole contributed to the dollar weakness

The US employment report, although slightly below expectations, and the ISM manufacturing upturn confirm our forecast for a 25bp Fed Funds rate hike at the end of 2017

In India, the second quarter’s unexpected slowdown in activity primarily factors in the introduction of the goods and services tax. It should be temporary, as shown by the leading indicators

Like each year at the end of August, the speeches by central bankers at their Jackson Hole conference in Wyoming, USA, were eagerly awaited.

Several times in the past, this annual event has been an opportunity for the central banks to reveal a shift in their monetary policies. For instance, when he was Chairman of the US Federal Reserve (Fed), B. Bernanke suggested in 2010, then again in 2012, that the Fed was about to adopt new quantitative easing programmes. In 2014, M. Draghi, President of the European Central Bank (ECB), indicated that new monetary easing measures were going to be implemented. More recently, in 2016, J. Yellen confirmed that after taking a break since December 2015, the Fed was planning to resume its process to gradually raise the Fed Funds rate over the following months (as seen in December 2016).

This year however, in line with our expectations, the central bankers’ speeches did not reveal any new information concerning the direction of their monetary policies in the US or eurozone: neither J. Yellen, nor M. Draghi mentioned monetary policy issues. Instead, both of them spoke about structural issues, with J. Yellen focusing on the benefits of financial regulation and M. Draghi covering the risks posed by stronger protectionist measures for world growth.

Nevertheless, these speeches have had an impact on monetary policy expectations. The fact that M. Draghi did not mention the ECB’s policy seems to have been interpreted as implied approval of the euro’s current level against all currencies, despite its significant appreciation recently. For J. Yellen, the lack of any indication concerning the outlook for the Fed Funds rate has been seen as confirmation of the legitimacy of rate expectations on the financial markets, with the Fed expected to maintain a monetary statu quo for the rest of the year.

The euro has therefore continued to appreciate against the dollar following these speeches. While expectations for the Fed to maintain a monetary statu quo through to the end of 2017 had climbed from 62.6% on 25 August, when J. Yellen and M. Draghi made their speeches, to 72.2% on 28 August, the euro‑dollar exchange rate reached 1.2070 during the session on 29 August.

However, the euro’s rise against the dollar was interrupted in the following days, after several statistics were released in the US.

The most important was the US job market report, which revealed that 156,000 jobs were created in August. The unemployment rate is up from 4.3% to 4.4%, while under-employment is stable at 8.6%.

While these job creation figures came in slightly below the monthly average of 176,000 recorded since the start of this year, and lower than expectations, they are still encouraging for an economy that has reached full employment (see left-hand chart, p.3). According to the Fed, the creation of 100,000 jobs should be enough to simply absorb the new people entering the job market. The actual job creation figures reported are significantly higher than this and the outlook is also promising: the “employment” subcomponent from the ISM manufacturing index, a purchasing manager survey, reached a six-year high of 59.9 in August, while the NFIB survey for American small businesses, which account for the vast majority of US jobs, indicates that 19% of businesses are planning further recruitments, its highest level since November 2006 (see right-hand chart, p. 3). As labour supply becomes increasingly scarce, employees are expected to be in a stronger position to negotiate higher wages. While August saw year-on-year wage growth of 2.5%, in line with their growth for the past four months, we are still forecasting an acceleration in wages between now and the end of the year.

Alongside this, the ISM manufacturing index climbed to a six-year high of 58.8 in August, after 56.3 in July, confirming the US economy’s strength, with significant progress for the employment, production and order book subcomponents. [...]

The slowdown in corporate credit is not (yet) a cause for concern

US business debt levels have never been so high and credit growth has been cooling for the past few months. However, we are not yet forecasting a downturn in activity levels

With an extension of the economic cycle and easing of credit conditions, we expect this to support a slight upturn in borrowing in the short term

However, if the monetary tightening moves too quickly in 2018-19, this could threaten the sustainability of business debt, their high interest expense making them more sensitive to rate hikes

While debt for non-financial businesses, facilitated by an accommodating monetary policy over the past eight years, has significantly surpassed its pre-crisis levels, growth in business borrowing has cooled in the past few months. Growth in total outstanding bank loans dropped from 9.8% year-on-year between 2014 and mid-2016 to just 4.5% in July 2017. While banks’ lending conditions are still flexible on the whole and the number of business defaults is still low, demand from businesses has weakened more than the actual supply of credit. According to our analysis, the increase in the lending rates applied by banks and a higher interest expense could have pushed businesses to rein in their borrowing. However, we expect to see a slight upturn in borrowing in the short term, supported by the extension of the economic cycle, the easing of credit conditions and a slight drop in real rates. Looking ahead to 2018-2019 however, if Fed Funds rates were to rise too quickly, the sustainability of corporate debt could be threatened. Faced with higher interest expense, businesses are more sensitive to rate hikes. [...]

Lisa Turk, Economist, United States, with the Economic Research team at Edmond de Rothschild